As British manufacturers grapple with tightening margins and sluggish export growth, an apparently esoteric but consequential decision is looming. At the UK–EU summit in London next week, the possibility of linking carbon markets is on the table. The UK government should make this a priority.
The EU’s Carbon Border Adjustment Mechanism (CBAM) – which will apply a charge to EU imports based on their embedded carbon emissions – is set to impose new levies on many UK exports in a matter of months. Failure to agree a clear path towards linking carbon markets – and thereby exempt the UK from the EU CBAM – could compound existing pressures on the UK economy and stifle much-needed investment in the energy sector.
The UK’s position after Brexit
Carbon markets have been a central plank of UK and EU climate policy for over two decades. The UK was instrumental in developing the EU emissions trading system (ETS) in the early 2000s. It remained a participant until 1 January 2021 when, following its exit from the EU, it withdrew and began operating a highly similar but fully independent ETS.
The decision set the UK apart from non-EU European neighbours like Norway, which participates in the EU ETS, and Switzerland, which has a linked ETS.
However, the 2020 post-Brexit EU–UK Trade and Cooperation Agreement commits the two sides to giving ‘serious consideration’ to linking their systems. It is this that is up for discussion on 19 May.
The suggestion of linking carbon markets has drawn the ire of some MPs and commentators resistant to closer ties with the EU and hostile to climate policy in general. But failing to do so would constitute an act of self-harm for the UK.
The costs of failing to link
There is the simple economic rationale for linking carbon markets: bigger markets are more efficient. Manufacturers in the smaller, less liquid UK ETS are exposed to greater price volatility and have fewer hedging options than their EU ETS counterparts. That increases their costs and harms their competitiveness.
Carbon allowances under the UK ETS are currently trading at around £50, a discount of 15 per cent on the EU ETS. However, this relative cost advantage for British manufacturers will soon be cancelled out for many exports, with the imminent full implementation of the EU CBAM.
The goal of the CBAM is to prevent EU industry being undercut by producers in jurisdictions which apply a lower carbon price, or no carbon price at all. It currently applies to imports of cement, iron and steel, aluminium, fertilisers, electricity and hydrogen.
56 per cent of UK exports in these sectors went to the EU in 2024. From 1 January 2026, a top-up levy – equivalent to the prevailing difference between UK and EU carbon prices – will be applied at the EU border. The aim is to ensure that the total carbon price paid is not less than the EU carbon price.
Crucially, this levy will go into the coffers of the importing EU member state, rather than the UK Treasury. That will deprive the government of much-needed revenue it might otherwise invest in decarbonizing industries affected by the CBAM.
The lack of a formal link between the UK and EU carbon markets also creates an unwelcome administrative burden. Under the CBAM, EU importers of affected goods must obtain emissions data from their UK trading partners.
Similar data is collected under the UK ETS. But reporting obligations differ to those of the EU, effectively requiring ‘translation’ from one system to another. This increases complexity and transaction costs, dampening the appeal of UK products in its largest export market.
For these reasons and more, representatives of British industry convened by Chatham House, along with other businesses and industry groups, have expressed near unanimous support for linking the UK and EU ETS. For them, the choice is stark: secure access to European markets on competitive terms, or face a future of diminished export potential and continued industrial decline.
Energy security benefits
Linking would also boost the UK’s energy security. Britain’s grid is connected to continental Europe and the island of Ireland by 9.8GW of interconnectors. These enable electricity generated overseas, including by French nuclear power plants and Norwegian hydroelectric dams, to flow freely and directly into the UK when it is needed.
These interconnectors also enable UK offshore wind power producers to export electricity at times of surplus, which can be sizeable at night when wind speeds are high and demand is low. This opportunity for revenue from outside the UK incentivizes investment in new infrastructure within the UK, driving up the share of low-cost renewables in the UK’s energy mix, driving down the need for expensive imported gas.
And this opportunity is growing. British electricity exports have increased markedly in recent years, totalling £545 million in 2024, almost quadrupling since 2020.
